Swiss Re Insurance-Linked Fund Management

Original Risk: A Society for Change Agents

Expecting ILS capital to exit after losses or rate rises is ‘overly simplistic’


The suggestion that insurance-linked securities (ILS) investors will flee from the reinsurance market, after a large industry loss or as soon as interest rates rise, is an ‘overly simplistic’ view on the sector according to market participants.

Participants in investment bank Macquarie’s 2014 Bermuda in Boston conference, held last week, discussed the likelihood that capital would exit ILS after catastrophe losses or interest rate rises and just what type of event could result in a significant departure of capital.

Panelists discussed what might make capital flee from the ILS space and agreed that it would take something truly exceptional to scare investors away. The participants agreed that expecting ILS capital to flee the market in the face of catastrophe losses or rising interest rates was an overly simplistic view of the sector and its investor base.

Lixin Zeng, CEO of AlphaCat Managers Ltd., the ILS arm of reinsurer Validus, said that it would take an “unknown unknown” for investors to feel concerned enough to result in a flight of capital and that if such an event occurred it would also cause capital to flee from the traditional reinsurance space as well.

A true unknown unknown industry loss or catastrophe event might suggest a gap in the risk models which could result in significant depletion of capital and a loss of confidence in the ability of reinsurers to manage their risks.

Barney Schauble, Managing Partner at Nephila Advisors LLC, added that ILS investors had already been through Katrina, Rita and Wilma in 2005, weathered those losses, then also faced the financial crisis in 2008 with few players exiting the market after those events.

Indeed, some of the larger ILS managers operating across the spectrum of ILS investments and structures pay claims on a regular basis. With ILS capital now participating in many of the world’s largest reinsurance programmes, the exposure to losses goes far beyond the largest events and ILS funds and managers pay claims on attritional events much more frequently than many people realise.

The question of whether capital will ‘flee’ is often raised by some on the traditional side of the reinsurance market, but in reality what could happen after a major event is more of a redistribution of capital rather than it exiting the space entirely. A major loss, particularly an unexpected one, may show up the differences in strategy and levels of underwriting discipline between some players and also could result in some ILS funds needing to liquidate positions very rapidly.

That provides opportunities for redistribution of capital, for the least affected managers to pick up new investors and for some liquidated positions to be transferred or sold at attractive prices. The post-event ILS world could be extremely interesting and may result in more opportunity which in turn attracts more capital, not less. It is far too simplistic, in our opinion, to say that investors who have in some cases spent years analysing the asset class would just leave at the first sign of a sizeable loss.

Panelists agreed that alternative reinsurance capital, ILS and the investor base is more than just a “pile of cash” and that the expertise and sophistication, of both the providers, or managers of the money and the capital markets investors themselves, would likely make ILS a long-term fixture in the reinsurance market.

Read our other article featuring commentary from the Macquarie event:

Alternative capital could take 50% or more of global prop cat market.

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